06--Ch. 6--189-232 10/4/07 9:31 AM Page 189 6 Postrevolutionary Stabilization: 1999–2003 Moscow was awful in September 1998.1 The financial system had stopped functioning. Credit cards and the many ATMs could no longer be used. I was organizing an international conference in Moscow, and we had to pay for everything with cash. The ruble had collapsed, and hyperinflation was an evident threat. The talk of the town was whether Russia’s market econ- omy experiment had failed. The New York Times Magazine carried an arti- cle by John Lloyd (1998) titled “Who Lost Russia?” Russia’s postcommu- nist transformation looked like a complete failure. On August 23, 1998, six days after Russia’s financial crash, President Yeltsin sacked Prime Minister Sergei Kirienko and his cabinet. The public mood called for old, experienced hands. Yet, when Yeltsin nominated Vik- tor Chernomyrdin, whom he had dismissed five months earlier, Moscow laughed in sad disbelief. Had Yeltsin lost his senses? Few were as guilty for the August crash as Chernomyrdin. The communist-dominated Duma turned Chernomyrdin down twice. On September 10, Yeltsin reconsid- ered and nominated his minister for foreign affairs, Yevgeny Primakov, who had previously been head of SVR, Russia’s foreign intelligence ser- vice. Primakov was the single survivor from Gorbachev’s time and close to the communists, who happily confirmed his appointment the next day. Primakov formed a cabinet tainted by Soviet nostalgia. Nikolai Ryzh- kov’s old chairman of Gosplan, Yuri Masliukov, an unreformed commu- nist, was appointed first deputy prime minister for economic affairs. Viktor Gerashchenko became chairman of the central bank for the third time, as if 1. Overall references for this chapter are Baker and Glasser (2005), Shevtsova (2005), and Jack (2004) for politics; and Åslund (2004) for economics. 189 Peterson Institute for International Economics | www.petersoninstitute.org 06--Ch. 6--189-232 10/4/07 9:31 AM Page 190 he had not done enough damage already. Gennady Kulik, my old antire- form friend from the Soviet Ministry of Agriculture, became deputy prime minister for agriculture. The prime minister and the Duma had taken over power, marginalizing Yeltsin. Yet, quite a few ministers remained in office, notably Mikhail Zadornov as a sensible minister of finance. Rarely has a situation turned into its opposite faster than after August 1998. Russia’s market economy had not failed but graduated. Its apparent devastation was nothing but a catharsis. Finally, Russia attained sound fi- nancial stabilization and steady economic growth started. The last year of Yeltsin’s presidency, 1999, saw no fewer than three prime ministers, and Yeltsin selected the last of them, Vladimir Putin, as his suc- cessor. Putin started a relentless rise in popularity and power. His advance was driven by dark events—the bombing of apartment houses with hun- dreds of victims, and a large armed incursion into neighboring Dagestan by Chechen rebels. The Kremlin used these tragedies to justify a second war in Chechnya that was as brutal and bloody as the first one. Putin used this war as his election campaign. The Duma elections in December 1999 and the presidential elections in March 2000 were nothing but Putin’s coronation, and the newly elected president used this mandate to impose major changes. Politically, Putin favored centralization and authoritarianism. He broke the back of the media oligarchs, chasing them into exile, while gradually consolidating his power. The Russian federal-regional relations had never worked well, and Putin chose a far-reaching recentralization, which he called strength- ening the “vertical of power.” Economically, however, Putin promoted market reforms. The many unfulfilled reform projects were put into a comprehensive reform program, and many impressive reforms were un- dertaken. Putin also launched an extensive judicial reform that he called “the dictatorship of law.” Russia undertook serious attempts to join the World Trade Organization (WTO) as well. The Russian state was back. Putin had turned the tables on the oli- garchs, and he had consolidated power, but the question remained: What kind of Russia did he want to build? Finally Financial Stabilization During the first half-year after the crash of August 1998, the new Pri- makov government did not really have any policy. It was governed by ne- cessity and prior reform proposals, especially the substantial program the Kirienko government had concluded with the IMF and the World Bank in July 1998. The default forced vital fiscal reforms upon the country. As no financ- ing but tax revenues was available any longer, the budget deficit had to be eliminated. Renewed external default loomed if the government failed 190 RUSSIA’S CAPITALIST REVOLUTION Peterson Institute for International Economics | www.petersoninstitute.org 06--Ch. 6--189-232 10/4/07 9:31 AM Page 191 Figure 6.1 Consolidated state revenues and expenditures, 1992–2005 percent of GDP 70 60 50 Expenditures 40 30 Revenues 20 10 0 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Sources: EBRD (2000, 205; 2003, 187; 2005, 173; 2006, 169). to service the country’s foreign debt. Russia’s apparent political inability to balance its budget disappeared because the only alternative was hy- perinflation, which nobody wanted. Hence, no money was available for the expensive public investment program or for industrial subsidies, which Masliukov spoke about, or even for prior social transfers. The gov- ernment imposed new controls over both revenues and expenditures. First, the Primakov government undertook a major fiscal adjustment entirely through expenditure cuts, slashing Russia’s consolidated state ex- penditures by no less than 14 percentage points, from 48 percent of GDP in 1997 to 34 percent of GDP in 2000. All arguments about the impossibil- ity of reducing public expenditures fell by the wayside. Enterprise subsi- dies of little or no social benefit were eliminated, which leveled the play- ing field for Russian business. Much more controversial was the reduction of real pensions by about half from the summer of 1998 to early 1999, by not allowing them to rise with inflation. Revenues, by contrast, varied little (figure 6.1). The previously chronic budget deficit turned to the opposite. Since 2000, Russia has had persis- tent budget surpluses (figure 6.2). Second, the financial crash reinforced central state power. The water- shed was the budget of February 1999. It stipulated that offsets could no longer be used for payments to the federal government, which hit big cor- porations and regional governments (Owen and Robinson 2003, 37–38). POSTREVOLUTIONARY STABILIZATION: 1999–2003 191 Peterson Institute for International Economics | www.petersoninstitute.org 06--Ch. 6--189-232 10/4/07 9:31 AM Page 192 Figure 6.2 Budget surplus, 1999–2007 percent of GDP 10 8 6 4 2 0 –2 –4 1999 2000 2001 2002 2003 2004 2005 2006 2007E E = estimate Sources: EBRD (2005, 173; 2006, 169); Bank of Finland Institute for Economies in Transition, Russia statistics, www.bof.fi (accessed on July 31, 2007). From 2000, the requirement of only cash payments was imposed at the re- gional level, and the government ordered public utilities to do so as well. Bankruptcy legislation had long been on the books, but helped by a new aggressive bankruptcy law of 1998, the government started pursuing its claims with rigor. Barter and offsets were eliminated, clearing up chains of arrears. Barter payments between Russian industrial enterprises fell from a peak of 54 percent of all interenterprise payments in August 1998 to 14 percent in the fall of 2001, because barter had become unprofitable (figure 5.2). Large enterprises could no longer extract tax rebates through offsets, and regional governors could not divert federal funds. Arrears of pension and state wages dwindled. The monetization also leveled the playing field. As a result, many enterprises changed ownership, which revived them. Typically, old managers were forced to sell to hungry young entre- preneurs at rock-bottom prices. Third, the Primakov government continued the tax war on the oligarchs that the reformers had launched in 1997–98, and the newly strengthened state could beat the weakened oligarchs. The government started applying the tax laws to big enterprises, especially the oil and gas companies, which had previously enjoyed individually negotiated taxes. 192 RUSSIA’S CAPITALIST REVOLUTION Peterson Institute for International Economics | www.petersoninstitute.org 06--Ch. 6--189-232 10/4/07 9:31 AM Page 193 Figure 6.3 Total and federal state revenues, 1998–2002 percent of GDP 40 35 Total government revenues 30 25 20 15 Federal revenues 10 5 0 1998 1999 2000 2001 2002 Sources: Bank of Finland Institute for Economies in Transition, Russia statistics, www.bof.fi (accessed on June 20, 2007); EBRD (2006, 169; 2004, 169). A fourth measure was a radical centralization of government revenues to the federal government from both the regions and extrabudgetary funds. Federal revenues almost doubled from 11 percent of GDP in 1998 to 20 percent in 2002 (figure 6.3). The powers of the federal treasury were reinforced through the adoption of the new budget code in 2000. All state agencies had to make all their transactions through accounts with the fed- eral treasury (Diamond 2002). Some extrabudgetary funds were abolished and all were put under federal treasury control. The previously sizable road fund and the small employment fund were eliminated, while three social funds (pension fund, medical insurance fund, and social insurance fund) were financed by a unified social tax collected by the new tax min- istry, which further enhanced the federal government’s leverage (Owen and Robinson 2003, 34–39). Russia’s fiscal dimensions became reminis- cent of the United States, with total fiscal revenues of about one-third of GDP and federal revenues of some 20 percent of GDP.